Securities Act Updates Vol. III
On July 3rd, the SEC updated their list of common questions related to the Securities Act.
This series will detail the most pertinent of these updates, as many are relevant to Regulation D and accredited investor regulation. If anything is difficult to understand, we have provided simple translations and examples that should help clear up any confusion.
Question: Rule 506(c)(2)(ii)(A) sets forth a non-exclusive method of verifying that a purchaser is an accredited investor by, among other things, reviewing any Internal Revenue Service form that reports the purchaser’s income for the “two most recent years.” If such an Internal Revenue Service form is not yet available for the recently completed year (e.g., 2013), can the issuer still rely on this verification method by reviewing the Internal Revenue Service forms for the two prior years that are available (e.g., 2012 and 2011)?
Answer: No, the verification safe harbor provided in Rule 506(c)(2)(ii)(A) would not be available under these circumstances. We believe, however, that an issuer could reasonably conclude that a purchaser is an accredited investor and satisfy the verification requirement of Rule 506(c) under the principles-based verification method by:
- reviewing the Internal Revenue Service forms that report income for the two years preceding the recently completed year; and
- obtaining written representations from the purchaser that (i) an Internal Revenue Service form that reports the purchaser’s income for the recently completed year is not available, (ii) specify the amount of income the purchaser received for the recently completed year and that such amount reached the level needed to qualify as an accredited investor, and (iii) the purchaser has a reasonable expectation of reaching the requisite income level for the current year.
Where the issuer has reason to question the purchaser’s claim to be an accredited investor after reviewing these documents, it must take additional verification measures in order to establish that it has taken reasonable steps to verify that the purchaser is an accredited investor. For example, if, based on this review, the purchaser’s income for the most recently completed year barely exceeded the threshold required, the foregoing procedures might not constitute sufficient verification and more diligence might be necessary.
Translation: One of the requirements for accredited investors is a $200K+ annual income for the past two years. If, for example, the investor is being verified just after the end of the fiscal year, the IRS might not have the necessary forms prepared soon enough.
The issuer must then collect the following from the purchaser:
- IRS forms from the two most recent years (the two years preceding the newly-completed fiscal year)
- Written confirmation from the IRS that the most recent forms are not yet available
- Personal income records for the newly-completed fiscal year
- A reasonable expectation that the purchaser will satisfy income requirements for the current year
If these documents give the issuer a strong impression that the purchaser meets accredited investor requirements, they are admissible for use as verification. Otherwise, more information should be gathered.
Advice: Especially when using alternate methods of verification for accredited investors, always be sure to thoroughly research financial information. If a chance coincidence requires a strong investor to use alternate methods of verification, help them make the process as simple as possible. However, if it’s uncertain whether or not an investor will meet accreditation criteria, and they then need to use alternate verification methods, be cautious. Do the extra work to make absolute certain that investor will meet the standards, otherwise you might find yourself in trouble down the line.
We’re halfway through our SE Updates series, keep an eye out for Volume IV!